Strategy Session

What Is Operating Income?

Jul 14, 2022

One question that comes up very frequently in our office is what is operating income?

And before understanding what the answer is to what is operating income, we need to understand the elements that are involved in creating the operating income inside of business. So there's really three key attributes that are inside operating income. 

The very first is revenue.

So revenues generated when we sell or deliver a product or service to our end consumer. So whether we're buying or selling a product or we're delivering a service. All of those different mixes and all those different service or product lines make up our total revenue inside our business. 

The second element of operating income is understanding what variable costs are.

So variable costs are costs that are incurred directly attributed to delivering the revenue in question. So for example, if we are buying and selling computers, obviously the sale of a computer is our revenue and the cost of buying that computer or the cost of manufacturing that computer is really our variable cost.

So, what could be in variable costs?

It could be labor, it could be purchases, it could be direct marketing Costs to acquire that revenue. So anything, again, that is directly attributed to delivering that revenue is considered a variable cost, and it's variable because it will fluctuate up and down based on the volume of revenue that's being delivered inside the company. 

And the third element of operating income is understanding fixed expenses.

So fixed expenses, as the name suggests, are fixed from a month to month basis.

Now, there may be some fluctuation, but typically they aren't going to fluctuate based on the volume of revenue inside of business. So one really good example would be utilities cost or hydro costs inside of business. It may fluctuate slightly based on the usage, maybe based on the outside temperature, but it's not going up or down based on the direct volume of revenue that we're creating inside the company.

So understanding operating income, revenue minus our variable costs gives us our gross profit or our gross margin less our fixed expenses gives us our operating income inside our business.

Why is it important to know what our operating income is?

It's super important because if we don't have a business that is financially sustainable and generating bottom line operating income, then we don't have a viable operation and don't have a future inside our business.

So what's the very first thing we need to do?

The very first thing we need to do inside our business is make sure our numbers are up to date and that we have access to it. So we have informed information that we can make solid financial and business decisions on.

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